CFTC Clarifies That Variation Margin Constitutes Settlement

The Division of Clearing and Risk (DCR) of the Commodity Futures Trading Commission has issued an interpretive letter clarifying that payments of variation margin, price alignment amounts and other payments in satisfaction of outstanding exposures on a counterparty’s cleared swap positions constitute “settlement” under the Commodity Exchange Act (CEA) and CFTC Regulation 39.14. The CEA and CFTC Regulation 39.14 provide that a derivatives clearing organization (DCO) must effect a settlement at least once each business day and ensure that settlements are final when effected.

Although not mentioned by DCR, the letter is clearly intended to complement earlier guidance issued jointly by the Federal Reserve Board, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation (Guidance) regarding the Regulatory Capital Treatment of Certain Centrally Cleared Derivatives Contracts Under Regulatory Capital Rules. As the Guidance explains in greater detail, for purposes of the risk-based capital calculation and the supplementary leverage ratio calculation, the regulatory capital rules require financial institutions to calculate their trade exposure amount with respect to derivatives contracts. The trade exposure amount, in turn, is determined, in part, by taking into account the remaining maturity of such contracts. The Guidance goes on to explain that for a derivatives contract that is structured such that on specific dates any outstanding exposure is settled and the terms are reset so that the fair value of the contract is zero, the remaining maturity equals the time until the next reset.

“Accordingly, for the purpose of the regulatory capital rules, if, after accounting and legal analysis, the institution determines that (i) the variation margin payment on a centrally cleared Settled-to-Market Contract settles any outstanding exposure on the contract, and (ii) the terms are reset so that fair value of the contract is zero, the remaining maturity on such contract would equal the time until the next exchange of variation margin on the contract.”

CFTC Letter No. 17-51 provides the legal analysis to confirm that, as a condition of registration with the CFTC as a DCO, each DCO must provide for daily settlement of all obligations, including the payment and receipt of all variation margin obligations, which payments are irrevocable and unconditional when effected. As a result, a clearing member’s obligations to each DCO are satisfied daily and the fair value of the open cleared derivatives held at the DCO is effectively reset to zero daily.